Merrill Lynch's profit rises 31%

GregMorcroft

NEW YORK (MarketWatch) -- Merrill Lynch & Co.'s second-quarter net income rose 31%, driven by strong proprietary trading and a booming international investment-banking business, the brokerage giant said Tuesday.

It also said it managed to avoid much fallout from subprime credit issues, maintaining that risk is well managed in a business that accounts for only a small portion of overall revenues.

"In our view, the quarter showed that Merrill has navigated recent market problems quite well and that the issues of market concern are not a major driver of its earnings," Deutsche Bank analyst Mike Mayo wrote in a research report assessing the quarterly results.

Analysts polled by Thomson Financial had expected the company to earn $2.02 a share on revenue of $9.25 billion, on average.

The company said quarterly revenue from principal transactions, or investments made with the firm's own assets, more than doubled, climbing to $3.55 billion from $1.18 billion.

"As we increase our risk-taking capabilities and increase our focus on trading, you will see and you have seen a general migration in our revenue lines from net interest to principal transactions," said Jeff Edwards, Merrill's chief financial officer, during a Tuesday conference call.

Shares of Merrill slipped 86 cents, or about 1%, to change hands lately at $86.53.

Strong principal performance

Merrill booked 36.5% of its total second-quarter revenue from principal transactions, up from 27.7% in 2007's first quarter and 14.4% in the year-ago second quarter. Revenue from principal transactions hit $3.54 billion in the quarter, more than double year-ago results.

And, reflecting a growing trend in investment banking, Merrill Lynch said 61% of its net trading and investment-banking business came from outside the United States.

Rivals Lehman Bros. and Goldman Sachs, both of which reported financial results last month, also noted strong growth outside the U.S., with Goldman saying that about 52% of its business was international in nature.

During the latest quarter, Merrill said 64% of total net revenue and 69.5% of pretax profit were generated outside the United States.

CFO Edwards said the backlog of investment-banking business is at a record high.

Edwards also said that the company's total exposure to subprime loans "is limited, contained, and appropriately marked."

"I think the majority of our exposure continues to be now in the highest-credit segment of the market," Edwards added during the call.

Over the last year and a half, that subprime business was less than 2% of Merrill's revenue, he said.

"These results should alleviate most investor concerns that Merrill is overly exposed to deteriorating subprime mortgage markets and challenging CDO/CLO markets," Goldman Sachs analysts said in a research report Tuesday.

Edwards said Merrill expects to continue lending to private-equity firms for leveraged buyouts, despite worries that higher margin requirements and tougher vetting are hurting that business.

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